The Balassa-Samuelson Effect,Exchange Rate Pass-through And The Changes Of Real Exchange Rate

Exchange rate plays a key role in the open economy that varieties of macro andmicro economic factors cause fluctuations in exchange via different ways, and theexchange rate has a significant effect on other economic variables at the same time.Exchange rate, therefore, has been an important issue on the research of internationalfinance. With the development of China’ s exchange rate reform, the research onexchange rate flexibility and its influencing factors are becoming more and moresignificant.The real exchange rate is decomposed into the deviation from law of one price oftradables and relative price changes in this article. The third chapter, first of all, presentsstudy of the significance of the Balassa-Samuelson effect in China based on thetraditional Balassa-Samuelson effect theory, and then does research to verify theestablishment of the Balassa-Samuelson effect theory which incorporated the factor ofthe deviation from law of one price of tradables. The fourth chapter deepens factors ofthe deviation from law of one price of tradables on the basis of the former study, tracesits determining factors behind such as degree of exchange rate pass-through and tradeopenness. Then studies the direction and magnitude of effects on the real exchange rateunder the combination of the degree of exchange rate pass-through, trade openness andrelative labor productivity, and investigates their effects in regimes on the real exchangerate, trying to help us deeper sense of the unignorable role played by the deviation fromlaw of one price of tradables on the real exchange rate. And the paper draws thefollowing several conclusions:Firstly, just considering the productivity factor purely, productivity has a negativeeffect on the real exchange rate which will appreciate with the enhancement ofproductivity, the Balassa-Samuelson effect is insignificant. It is found that the deviationfrom law of one price of tradables has a positive effect on the real exchange rate, whichleads to a depreciation of the real exchange rate when incorporating the deviation fromlaw of one price of tradables. Then productivity has a negative effect on the realexchange rate which will appreciate with the enhancement of productivity and theBalassa-Samuelson effect is significant.Secondly, after taking into account the factor of the deviation from law of one price of tradables, roughly relative labour productivity has a positive effect on the realexchange which accorded with the Balassa-Samuelson effect theory from theperspective of influence direction. From the perspective of two-regime, the relativeproductivity in regime1has a negative influence on the real exchange rate, revealingthat the Balassa-Samuelson effect is not significant, but the relative productivity inregime2has a positive effect on the real exchange rate and the Balassa-Samuelsoneffect is true. Exchange rate pass-through has a positive effect and trade openness has anegative effect on the real exchange either in general or in regime.Third, after taking into account the factor of the deviation from law of one price oftradables, cointegration relationship exists between the various factors and the realexchange.Totally, and vector error correction model shows that the real exchange rateis in line with the principle of reverse correction. In regime the markov regime vectorerror correction model (MS-VECM model) test also shows that the real exchange rateis in line with reverse correction mechanism no matter in what terms of the system.When the real exchange rate deviates from the equilibrium real exchange rate, it willgradually return to balance.Fourth, after taking into account the factor of the deviation from law of one priceof tradables, from view of the impact on the real exchange rate (relative strength)ofthe contribution of each factor, in general, exchange rate pass-through for the changesof real exchange rate plays a more important role, and the impact of relativeproductivity ranks the second. It also verified the point expressed by some literature thatthe role of taking the view of relative price changes is less to to explain than to takingthe view of the deviation from law of one price of tradables. However, due to thecurrent technical restrictions, we can not test this in different regimes, it remains to beconfirmed by futher research.Fifth, from the perspective of influence contribution of each factor in differentregimes on real exchange rate, exchange rate pass-through shows different aboutinfluence contribution, in regime2exchange rate pass-through plays a more significantrole of influence on real exchange rate, while trade openness in two-regime has almostthe same effect.In summary, after taking into account the factor of the deviation from law of oneprice of tradables, especially considering the factor of exchange rate pass-through, wedraw some meaningful conclusions. Therefore, the impact of exchange ratepass-through can not be ignored when do studies of the trend of RMB real exchange rate. And we grasp the whole trend if just doing research through the full sample period,but we will ignore the part-time segment abnormalities. So we should studied fromdifferent perspectives, then we can search for varieties of the real exchange rate indifferent times, under the influence of different factors more carefully.